Brazil’s Former Central Banker Says Economic Woes Are Home-Grown

RIO DE JANEIRO — The sluggish economic growth and high inflation fueling pessimism about Brazil are more self-inflicted than the result of outside influences, as the government has failed to restrain spending and curtail interventionist economic policies, according to Arminio Fraga, Brazil’s former central bank president.

Sentiment over Brazil has swung from euphoria to pessimism in the space of two years, reflecting the ups and downs of the economy. After a surge back from the global crisis with 7.5% growth in 2010, two poor years have culminated in last year’s growth of 0.9%. The outlook for 2013 isn’t much better.

“Our main problems are internal, as always,” said Mr. Fraga, also a former fund manager for billionaire George Soros, in an interview at his offices in Rio de Janeiro. “I would intuitively say that the order of magnitude is of four or five to one,” he added, comparing the impact of domestic and international problems on the Brazilian economy.

The criticism of the administration of President Dilma Rousseff comes from an economist who ran Brazil’s central bank from 1999 to 2002 under former President Fernando Henrique Cardoso. Mr. Fraga, 56 years old, won much credibility for re-establishing stability after the floating exchange-rate regime was adopted, and for introducing inflation targeting. Before that, he had worked for Mr. Soros and his Quantum Fund.

Mr. Fraga now runs Gavea Investimentos, a Brazilian asset-management firm he helped found in 2003, which has around $7 billion in assets under management. In 2010, J.P. Morgan Chase & Co. bought a majority stake in the firm.

External events seen affecting Brazil–slower growth in China, which consumes a lot of Brazilian raw materials, and a possible end to U.S. monetary stimulus–have been less of a problem for the South American country than its own failure to rein in inflation and curtail public spending, according to Mr. Fraga.

A reduction in Fed asset-buying, which could be seen as a positive sign of a healthier U.S. economy, could cause difficulties for bond markets that have benefited from abundant flows, he said. Brazil’s dependence on China, meanwhile, is less than many think given its closed economy, he added.

Mr Fraga said he believes that since 2006, economic policy under former President Luis Inacio Lula da Silva and then under his hand-picked successor, Dilma Rousseff, has been much more statist, boosting the role of public-sector banks while showing less concern for the efficiency of business and leaving Brazil with inadequate infrastructure.

“This model hasn’t been able to deliver the expected rate of growth,” he said.

A spokesman for Mr. Silva said the former president declined to comment for this article. A spokesman for President Rousseff also didn’t comment.

Mr. Fraga is most concerned about what he sees as a weakening of two of the three main pillars of the economy that were a key part of the legacy of the Cardoso administration: public spending restraints and inflation targeting. He is less concerned about the third pillar, the floating exchange rate.

The government needs to bring inflation down to the 4.5% target and then slowly begin reducing that target. “The government has been trying to secure inflation by managing prices, a recipe that’s well known as doomed to failure,” he said. Inflation is currently 6.4%.

Mr. Fraga thinks the central bank will likely have to raise interest rates further in the short term to quell inflationary pressures, but that over the long term, with a little more fiscal discipline, the trend should be for rates to fall.

Brazil’s currency, the real, has weakened about 30% against the U.S. dollar over the last two years as the local economy has stalled and the U.S. economy has showed signs of recovery. The central bank’s regular interventions in the currency market to iron out volatility have led some to suggest Brazil has abandoned the floating exchange rate, but Mr. Fraga disagrees.

“The central bank has said it doesn’t have a goal, but the market understands that it has a goal,” Mr Fraga said. “In practice, it’s clear that it [the central bank] hasn’t made a huge effort to meet a particular value for the currency. I can only speculate that it’s concerned with volatility [when it intervenes], it’s not a sign of desperation.”

Recent protests saw hundreds of thousands of Brazilians pour onto the streets of cities and towns across the country to demonstrate against rising living costs and to demand better public services.

Mr. Fraga said the demonstrators were right to be angry: Taxes are very high, and people “have every right to complain about education, health and transportation.”

On the positive side, he said the government has made some changes recently, such as resuming the sale of concessions for private-sector firms to explore for oil and to manage some of the country’s largest airports, while also passing a law to encourage new investment in ports. Yet other harmful policies remain in place, such as a gasoline subsidy, which he said is “asphyxiating” the government-run oil company, Petroleo Brasileiro SA.

“It’s too early to throw in the towel and say Brazil has problems that can’t be solved,” he said.